Primer: Private Health Insurance
Nathan Barton l September 2011
Introduction
Key Takeaways
In its simplest form, health insurance is the business of
shared medical risk. There are two players in this
industry: insurers and beneficiaries. Insurers contract
with beneficiaries, agreeing to pay the costs of medical
care in exchange for a premium.
The Health Insurance Market Today
Private market insurers offer three services to
beneficiaries: traditional group plans, individual
policies, and self-funded services. Traditional group
plans include employer-based insurance and make up
60 percent of the insurance industry. Beneficiaries who
are unemployed, self-employed, or who do not receive
insurance through their employer may purchase
individual policies. These policies only make up 5
percent of the industry. Self-funded services are for
beneficiaries who self-insure but want help with
administrative issues like processing insurance claims or
other aspects of handling their employee benefit plansi.
Types of Plans
The industry provides five products and services:
preferred provider organizations (PPOs), health
maintenance organizations (HMOs), point-of-service
plans (POS plans), high-deductible health plans (HDHP),
and fee-for-service plans (FFS plans). See Chart 2 for the
enrollment data for each of the plans or organizationsii.
Current state of private insurance
 Health insurance plans fall in one of five
categories: PPO, HMO, POS, HDHP, or FFS.
 The top companies are UnitedHealth Group,
Wellpoint, Humana, Aetna and Cigna.
 Industry revenue is almost entirely from
premiums.
 Contrary to public perception, health insurance
market profits are low, relative to other
industries in the healthcare sector.
On the horizon: changes due to the PPACA
 Prohibition of insurers from denying coverage
because of pre-existing conditions.
 Extension of insurance coverage to 32 million
uninsured Americans and mandates that all
Americans have insurance.
 Creation of state-based insurance exchanges
for individuals to shop for health insurance.
 Introduction of new premium taxes,
potentially forcing small employers out of
business and removing insurance options.
PPACA will cause employers to drop coverage
 Currently, 60 percent of Americans have
employer-based insurance. About one in three
employers have said they will stop offering
insurance benefits in 2014.
Preferred Provider Organizations (PPOs)
PPOs contract with a limited number of healthcare providers that agree to care for any beneficiary participating in
the PPO in exchange for payment each time a service is rendered. Beneficiaries in the PPO agree to pay a monthly
premium and co-pay each time they receive a healthcare service. If a beneficiary chooses a provider not contracted
with their PPO, they will pay more out-of-pocket to receive careiii.
For more information, please contact the American Action Forum’s Director of Healthcare Policy, Michael Ramlet, at
mramlet@americanactionforum.org.
Figure 1: Types of Private Health Insurance Plans
FFS Plans
HDHPs
3%
5%
POS Plans
13%
PPOs
58%
HMOs
21%
Health Maintenance Organizations (HMOs)
HMOs are prepaid health plans that charge monthly
premiums and contract with doctors, hospitals, and
other healthcare service providers to accept their
participants. Typically, if a provider is not contracted
with the HMO the service provider will not accept the
HMO’s participants. Participants may be required to
provide a small co-pay, such as $5 for a doctor visit, or
$25 for an emergency room visitiv. In general, HMO
providers are paid on a per patient basis rather than for
each service.
Point-of-Service (POS) Plans
Under this plan, beneficiaries receive care from
providers contracted with their HMO. Beneficiaries can
also receive treatment from non-contracted providers,
as long as the needed treatment is covered by the HMO.
Additionally, a contracted doctor can recommend that a
beneficiary see a doctor or provider who is not a part of
the HMO. In this case, the beneficiary is allowed to visit
the referred doctor and the HMO will pay the same
amountv.
High-Deductible Health Plans (HDHP)
Figure 2: Major Private Health Insurersvi
HDHPs have higher annual deductibles (an amount of
Cigna
out of pocket costs the beneficiary incurs before the
Aetna
2%
insurance kicks in) but lower premiums relative to other
5% Humana
traditional health plans. They are often combined with
5%
Health Savings
Accounts
(HSAs) or Health
Wellpoint
Reimbursement Accounts (HRAs). HDHPs provide
9%
traditional medical coverage and enables participants to
save for future medical expenses. Additionally,
participants have greater flexibility and discretion about
how they use their healthcare benefits. Participants can
UnitedHealth
pay deductibles out-of-pocket or with funds from their
Group
health savings accountsvii.
15%
Other
viii
Fee-for-Service (FFS) Plans
Figure 2: Major
64% Private Health Insurers
FFS plans are the traditional method insurers pay for
healthcare services. Plans pay for specific healthcare
services whenever the patient receives that serviceix.
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Major Insurers
The insurance market is segmented with the five major companies controlling 36 percent of the market share. The
top firms are UnitedHealth Group, Wellpoint, Humana, Aetna, and Cigna (Figure 2).
According to their reports, all of the above companies saw earnings higher than expected in first and second
quarters of 2011. One probable reason for the higher profits is the stagnant economy forcing beneficiaries to put
off medical care to reduce their out of pocket costs which in turn reduced outlays for insurers. Larger companies
are also better able to negotiate down reimbursements and better manage administrative burdens.
Economic Impact
Since most industry revenue comes from premiums, the market forces that affect premiums also determine
revenue levels. There are three key factors that affect revenue through premiums: coverage costs, level of
unemployment, and disposable income. Understanding these forces is necessary to understand and or predict
industry profitabilityx.
First, when coverage costs increase, insurers must increase premiums to raise enough revenue to cover their costs.
Second, when unemployment increases, there are fewer people with employer-sponsored insurance. With fewer
people enrolled in insurance plans, total revenue from premiums decreases. Lastly, when disposable income
increases, more individuals purchase health plans.
Other revenues come from administrative fees related to managed care services and medical data management.
However, note that an increase in revenue does not mean an increase in profits. The industry’s revenue in 2011 is
expected to be $677.3 billion. Its annual revenue growth rate for the past 5 years is 2.7 percent rising to 5 percent
over the next 5 years.
Figure 3: Comparison of Health Insurance Industry Costs and Average Sector Costs
0.7
3.6
Other
70.3
87.8
Purchases
Wages
Profit
13.5
4.5
7
12.6
Health insurance industry
Average of all industries in sector
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High Expense, Thin Profits
Reports often discuss huge profits in the health insurance markets. After close examination, however, it is clear
that is not the case. Insurers actually operate on thin profit margins, relative to other industries. Figure 3 compares
operating expenses and profits in the health insurance industry to operating expenses and profits in other
industries in the healthcare sector. Strikingly, average profits for all industries in the sector are 12 percent, almost
twice as much as the profits in the health insurance industry. In fact, IBISWorld reports that profits in the health
insurance industry will decrease over the next 4 years from 7 percent to 4 percentxi.
How the Affordable Care Act Affects the Industry
The recent healthcare legislation—the Patient Protection and Affordable Care Act (PPACA)—increases insurance
coverage to 32 million uninsured Americans. There is a lot of uncertainty as to what the newly enlarged pool of
beneficiaries will do to the premium costs.




Prohibits insurers from dropping coverage on sick people and from enforcing lifetime coverage and annual
limits. Due to the adverse selection problem, many insurers are concerned that they will not be able to
provide the same coverage and scope of benefits and stay profitable.
Mandates insurance exchanges in each state by 2014. McKinsey recently released a study indicating that
1/3 of 1300 employers would drop employer-sponsored coverage in 2014 as a result.xii This was not
expected in original estimates and could drastically raise the cost of paying for PPACA.xiii
Introduces new premium taxes, potentially forcing small employers out of business and removing insurance
options.xiv
Requires that insurers spend 80-85 percent of their revenue on medical care in, known as the “medical loss
ratio” (MLR). If insurers fail to MLR standards in 2011, then they will have to issue rebates in 2012xv. Firms
are concerned about the additional accounting and compliance costs.
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The American Action Forum is a forward-looking policy institute. The Forum produces realtime, fact-based, innovative policy analysis and solutions for policy makers and the public
alike. Our mission is to promote common-sense, innovative and solutions-based policies that
will reform government, challenge outdated assumptions, and create a smaller, smarter
government.
Operation Healthcare Choice is the Forum’s public policy center focused on promoting highvalue healthcare and higher quality health insurance that expands consumer choice. Operation
Healthcare Choice experts conduct research, offer commentary, and develop policies aimed at
eliminating healthcare’s burden on the economy.
References
i
ii
Andrews RJ. “IBISWorld Industry Report 52411b: Health & Medical Insurance in the US.” August 2011.
Ibid.
Ibid.
iv
Ibid.
v
Ibid.
vi
Ibid.
vii
Ibid.
viii
Ibid.
ix
Ibid.
iii
x
xi
Ibid.
xii
Ibid.
Singhal S, Stueland J, & Ungerman D. “How US health care reform will affect employee benefits.” McKinsey Quarterly.
http://www.mckinseyquarterly.com/How_US_health_care_reform_will_affect_employee_benefits_2813. Accessed June 25, 2011.
xiii
Cook B. “More employers consider dropping health coverage, report says.”
http://www.ama-assn.org/amednews/2011/06/20/bisa0620.htm. Accessed June 21, 2011.
xiv
Holtz-Eakin D. Testimony before the House Committee on Small Business.
http://smbiz.house.gov/UploadedFiles/Holtz-Eakin_Testimony.pdf. July 26, 2011.
xv
National Coalition on Health Care. “HHS Releases the MLR Regulation.” Nov. 22, 2010. http://nchc.org/content/hhs-releases-mlr-regulation.
Accessed June 25, 2011.
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